Banking as destiny?

FDIC's John Anderlik looks at rural communities and their banks

Editor's note: In recent decades the fate of many rural
counties in the Great Plains has been tied to various phenomena,
but ultimately everything comes down to demographics. If people
aren't willing to live in a county, and especially if young people
of childbearing age are moving out, then there is little hope
for the future. But what about rural banks? What can they tell
us about the health of a county's economy? Recent research from
the Kansas City office of the Federal Deposit Insurance Corp.
looks at the relation between banks and rural economies,
and in the following interview, John Anderlik, regional manager
for the FDIC's Division of Insurance and Research, sheds light
on those and other questions.

People in the Great Plains are well aware that many counties
are losing population and that this is putting strains on existing communities.
But of these declining counties, you distinguish a particular subset,
accelerated declining counties, for particular analysis. What are those?

Since 1970, nearly three-quarters of the rural counties of the Great Plains have lost population. We identified other areas in the nation that are also experiencing population outflows, but the problem in the Great Plains is far more advanced. A major point of our research is that it isn't simply a rural issue. In fact, there's a significant disparity among rural counties.

We segment rural counties into three groups, using census data between 1970 and 2000 for our analysis. We identified growing counties, which are those that gained population; declining counties, which lost population but at a relatively constant rate; and then, as you mentioned, there are accelerated declining counties that not only lost population, but in the 1990s lost population at a faster rate than they did in the prior two decades.

As far as what the typical accelerated declining county looks like—this county is slowly withering. Young people have left the community for job opportunities elsewhere, and since these people tend to be of childbearing age, these communities tend to have far fewer children and far more older people than more vibrant communities. In these counties, often the bank is one of just a few businesses still operating in town. Main Street storefronts sit empty, and oftentimes the towns have no grocery store or even a filling station. When our examiners go out to examine banks in these areas sometimes they have to travel to another town to get a bite for lunch because of the lack of a local diner. In addition, the housing stock is generally old and outdated, and many of these communities struggle to maintain their public infrastructure, such as schools, government services and roads.

Broadly speaking, to what degree has the banking industry followed this depopulation trend? Are small rural communities losing their bank presence?

Despite the Great Plains demographic problems, which again are far more advanced than elsewhere in the nation, consolidation trends in the rural Great Plains are surprisingly similar to rural areas elsewhere. However, our concern is that going forward [bank] consolidation activity in the rural Great Plains may increase significantly in the relatively near future. And we have two reasons to be concerned about this.

First is that in the Great Plains, and in accelerated declining counties in particular, there is a disproportionate amount of older people. When they begin to pass away, it's going to be relatively devastating for community banks because these folks represent a pretty good percentage of community bank funding.

The other factor that might increase consolidation going forward is a general lack of bank succession plans in these rural areas. In other words, when bankers retire, will there be well-qualified people available to take their place at the helm? What we commonly see is that the typical owner/manager of a bank located in depopulating areas is an older person whose heirs have long since moved away, so there's no family member to take over the business. Also, other candidates tend to be few as there is a shortage of qualified professionals in these areas.

So what we commonly hear when we go out and speak to banking groups is that the bankers don't really have succession plans at this point. They intend to continue to operate their institutions as long as they're able to do so, but at the point that they have to retire, there might not be any options available but to sell their institutions. So my view is that the succession plan issue may end up increasing consolidation activity in the future.

What is the value of a bank presence on small-town Main Street these days?

Academic research suggests that a local banking presence is essential because the bank manager tends to be the community's economic leader and a source of informal economic information. Certainly some depopulating counties are looking for economic development plans to revive their communities. Without a local banker the question isn't whether the plans would be successful, but whether those plans would ever be developed, since the banker tends to be the one who spearheads those efforts in the first place.

To what degree are declining counties banked vis-à-vis growing counties?

Growing counties certainly are home to more banks. Growing rural counties in the Great Plains have about 2.6 institutions per county, and in accelerated declining rural counties that number is 1.6. However, I should note that accelerated declining counties actually have more bank offices per capita than growing counties, though these branches tend to be smaller and may offer more limited banking services than the larger physical branches that are located in growing counties.

You mentioned branches. Is there a meaningful distinction between a branch and a bank in terms of impact on the economic life of these communities?

In general, not as much as you would think, although it depends on the institution the branch is associated with. If a small institution has purchased an institution and turned it into one of its branch offices, then what you might see is that the branch has reduced its banking services, perhaps now has shorter business hours, than if the bank was still locally owned and operated. On the other hand, a concern we hear from residents is that when a larger bank has purchased the bank and turned it into a branch, the local decision-making power is removed. For example, where customers used to be able to go and talk to a lending officer and get a decision, now the decision making typically has to go to the head office. So that makes life a little more difficult for those customers. But, in general, a bank branch and a headquarters are still going to offer essential services for these folks.

What can we determine from counties that have lost their banks? Can we predict, given demographic trends, which counties are likely to lose their banks in the future?

The conclusions about the counties that have lost their banks are actually pretty murky. We've examined consolidation patterns from year-end 1984 to year-end 2002, and we see that some accelerated declining counties have lost all their remaining headquartered institutions in that time. This was likely because as the populations decreased, there was less need to have banks located there. Perhaps a succession plan issue came to the forefront and these institutions were purchased by institutions outside the county. We can see this trend continuing in the future.

But on the other hand, just because a county doesn't have any headquartered banks doesn't necessarily mean that its demographic situation is adverse. For example, the Great Plains has five growing rural counties that also have lost all their remaining institution headquarters since 1984. We assume that these reasons are quite different from an accelerated declining county—that in growing counties the economic vibrancy has lured outside institutions to purchase local banks to gain a presence in these counties.

So there are some counties that are growing, despite the loss of a bank head- quartered there. Please tell us more about the performance of rural banks, especially those in declining counties.

In our research we focused on institutions in just the depopulating
rural counties of the Great Plains—those counties that we refer
to as declining or accelerated declining counties. We examined the performance
of "community banks," which we defined as banks and thrifts
with assets of less than $250 million as of the year-end 2002, because
we wanted to exclude larger banks that might have a presence in more
than one county. We looked at two variables, their asset growth and
pretax profitability between 1998 and 2002, as key measures of success.
Interestingly, even though these depopulating counties are showing very
similar demographic trends, the banking results showed significant disparity.

Generally what we found is that there are "haves" and "have-nots"
with regard to the institutions, and the results are likely dependent
on how successful bankers have been in managing their institutions in
tough economic times. One successful strategy has been for some banks
to pursue asset growth by branching into other counties—typically
growing rural counties or, in many cases, metropolitan counties. Some
of those institutions have then shown asset growth and also had relatively
high earnings as a result.

This indicates to us that these management teams were able to pursue
this aggressive growth strategy and still keep their costs down. They
had the appropriate knowledge of these new markets and the expertise
to make their plans successful.

On the other hand, there's another subset of banks that tried a similar
branching strategy that did result in asset growth, but at the expense
of earnings. So, our general conclusion would be that these managers
may not have had the expertise to handle the complexities and costs
of a multibranch bank or to branch into areas where they may not have
had the knowledge that they had locally.

There's also a subset of banks that had relatively low growth but yet
experienced high earnings. From the performance results it appears as
though these management teams used a strategy of cutting their operating
costs as low as possible, making profitable loans and achieving favorable
operating results despite the absence of growth you typically see in
a very profitable bank. Basically these bankers simply operate very
well.

But then there are also those banks that reported low growth and low
earnings, that have not pursued a growth strategy yet have also not
kept their operating costs in check.

It sounds like you need a special skill set to manage a bank in a rural community.

You know, I think you're right on that. The circumstances in these communities are very challenging, even if, as a banker, you just decide to operate solely within that county. At the minimum, you have to deal with a declining customer base. Funding is challenging in these areas, especially when large depositors pass away and their funds quickly leave the bank. But there's also very high competition in these rural areas despite the fact that the number of banks is declining. Competitive forces include not only other banks, but also lenders such as the Farm Credit System, equipment manufacturers and input suppliers who are making agriculture loans, and credit unions which, in some areas, are very big competitors for deposits.

Any optimistic notes in this dirgelike tune—perhaps for banks?

The only factor we hear people talk about with any kind of optimism is the Internet. To some, the Internet is seen as the potential cure for community banks located in depopulated counties. The Internet is a relatively cheap technology that could enable small banks in depopulating areas to go well beyond their market to sell products to people in metropolitan areas, the nation, even the world. The Internet may allow these banks to overcome demographic hurdles without having to build physical branches elsewhere.

On the other hand, the Internet might be a double-edged sword. We have concerns that the Internet will not only allow rural bankers to market their services elsewhere, but it will also allow banks located outside the rural areas to market their services to rural communities. In the past, geographic isolation has been both a handicap and an advantage for rural banks. Of course it was a handicap in that they were constrained to doing business in their local communities, but it has been a comparative advantage in that they had a relatively captive market.

For the most part, large banks didn't have an economic incentive to locate a branch in depopulating rural areas, so local banks were rural customers' only option. With the Internet, large banks will be able to easily market their products to rural customers, erasing rural banks' comparative advantage. The question is: Can these small, rural banks compete on a national scale with much larger banks that will be able to offer a wider array of banking services at lower costs because of their scale advantages? We wrote an article on the subject in our third-quarter 2002 Regional Outlook, and at this point we really don't know how that's going to play out. It could be positive, helping rural banks gain new customers, but it could also be very negative and accelerate the problems that already exist.

We've heard for a long time that the canary in the coal mine for small towns is their high school—you lose the school and you lose the town. But is the local bank the real canary in the coal mine?

That's a really interesting question. I think if I had to weigh the schools vs. the bank, I think the schools are probably more important, because people tend to follow the schools. We've seen school districts consolidate because the per capita cost of maintaining school districts in some small counties has gotten too high for residents to bear. And there's a saying out there that the high school is the community. Once a county loses its high school, it loses a lot of the young people who are the future of the community, and who also may work in that community and who definitely spend money in that community. That being said, I think the local bank is a close second when it comes to your canary question. Again, because if the county is going to design a realistic economic development plan to try to reverse its fortunes, a local bank would likely be at the forefront.